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Navigating the R&D Tax Credit: Internal Use Software

January 2020

Richey May is constantly looking for ways to improve our client’s experience as well as provide additional value.  With that in mind, we are excited to announce a three part series focused on Research and Development tax credits.  Part one includes the blog post below concerning internal use software; part two will include a webinar with Source HOV who specializes in research and development credits; and part three will include a case study illustrating first-hand the benefits realized by a current Richey May client in claiming research and development credits.  We hope you will join us on this journey as we take a deeper dive into research and development tax credits!  If you have any questions along the way, please reach out to your Richey May tax engagement team as we welcome the opportunity to further discuss this exciting topic  with you!

Internal Use Software (IUS) includes software applications, operating systems and related resources used to run a business and serve customers. Many small, mid-sized and even larger U.S. companies currently do not take advantage of Federal & State tax credits available for IUS research and development (R&D).

Companies often don’t seek R&D credits, because they don’t realize the credits are available to them or believe they don’t qualify. Others think it’s not worth the effort and are concerned that taking the credit increases their audit risk.

Facts:

• Companies are successfully applying for and receiving credits that provide hundreds of thousands to millions of dollars in tax savings or refunds.
• These savings are being realized from both a company’s current and prior year tax returns.
• Companies can take R&D tax credits for development of both IUS and software that is sold or licensed to customers.

What industries typically qualify for IUS R&D credits? While software-for-sale is largely the domain of IT companies, IUS is found in a variety of other industries, particularly in the services sector where technology is used to gain a competitive advantage to improve customer experience, expand product and service offerings, and streamline operations. Some industries rich in IUS R&D include:

• Information Technology
• Financial Services
• Travel
• Healthcare
• Real Estate
• Retail

Will my software pass the IUS 3-Part Test? When an activity has been identified as IUS, it must meet an additional 3-Part Test as well as the standard 4-Part Test for all other R&D activities.  The additional 3 tests are:

• Innovative

The internal use software developed should have been created with the intent to provide reduction in costs, improvements in speed, or other improvements that are substantial and economically significant.

• Significant Economic Risk

The internal use software developed should have required substantial resources in development and substantial technical uncertainty due to the technical risk that resources may or may not be recoverable within a reasonable period of time.

• Not Commercially Available

The internal use software developed should not be available for purchase and use without modifications.

Are IUS R&D credits worth pursuing? Simply determining whether software is for internal use or for sale can be difficult. The line between company and customer use can be blurry and the proliferation of delivery options from disks and downloads to leases, licenses, Software-as-a-Service (SaaS) and Cloud services further complicates matters.

That being said, companies are quickly expanding their use of technology, and the relentless, rapid evolution of that technology requires them to invest continually in improvements. As a result, there is a significant increase in the number of companies that are investing in IUS development.

Many firms refer their clients to specialized R&D tax credit firms, such as SourceHOV, that help identify qualifying R&D activities, carefully document claims, and present those claims in a coherent, understandable manner to help companies capture significant tax savings.

Want to learn more about Tax Innovation topics? Join us for our Webinar on January 28th!

This article and the upcoming webinar are in partnership with Source HOV.

Founded as LIFO Systems in 1983, SourceHOV Tax is a leading provider of specialized tax services. We work with accounting firms throughout the country to bring R&D tax credits, cost segregation, §179D, LIFO, §199, Fixed Asset Review, and §45L to their clients. With a team of 65 professionals and offices throughout the country, SourceHOV Tax serves many of the nation’s most prominent accounting firms, associations, and Fortune 1000 companies. Our mission is to build lasting relationships with our accounting firm partners, providing best-of-class service to help them meet their business goals. We help their clients save money and create cash flow that can stimulate their businesses.